S Corp vs. C Corp: Key Differences and How to Choose the Best Structure

When you’re ready to incorporate your small business, you’ll need to choose whether to form an S corp or a C corp. 

Is S corporation or C corporation the best business structure for your company? Each entity type has unique benefits, and the S corp vs. C corp decision can have complex implications. We’ll help you understand each structure’s characteristics.  

This article will compare the S corp vs. C corp business structures. You’ll learn the key differences and implications of choosing the best entity type for your business. 

Understanding Corporate Structures

Before learning the differences between S corp and C corp, you should understand the basics of the corporate structure. 

A corporation is a legal entity separate from its business owners, also known as shareholders. 

One significant benefit of the corporate structure? Corporations offer limited liability protection, which means shareholders cannot be held responsible for corporate debts or liabilities. Business owners gain protection from corporate claims. 

To form a corporation, the business owner must file articles of incorporation with the secretary of state. 

Incorporation documents establish a registered agent, adopt bylaws, and select the board of directors. After incorporation, the company should hold annual board meetings.

Every corporation must file annual reports and tax returns to maintain compliance. 

What Is an S Corp? 

The S corporation structure follows Internal Revenue Code Subchapter S rules. After incorporation, owners can elect S corp status by filing IRS Form 2553 (we’ll explain more about the election later).

S corporations are pass-through entities for income tax purposes, which means S corps do not pay corporate income tax on their earnings. S corps must distribute income and deductions to their shareholders annually. 

Each shareholder receives a prorated distribution determined by their ownership percentage. Shareholders pay tax on their share of business income and deductions. 

Business owners find the S corp business structure attractive because pass-through entities avoid double taxation. 

However, S corps must follow specific eligibility rules or risk terminating their S corporation election. S corp requirements include the following: 

• S corps cannot have more than 100 shareholders or more than one class of stock.
• Shareholders cannot be corporations, partnerships, or nonresident aliens. 
• S corps must generate less than 25% of their gross receipts from passive investment income. 
• S corporations must maintain records of each shareholder’s basis. 

S corp rules can be complex. We recommend consulting with accounting professionals who specialize in entity formations.

What Is a C Corp?

C corporations follow Subchapter C of the Internal Revenue Code. All newly incorporated businesses default to the C corp structure. 

C corporations can raise capital by adding unlimited shareholders, who contribute cash in exchange for business ownership. Shareholders can include individuals, partnerships, corporations, or other entities. Additionally, C Corps can issue multiple classes of stock. 

C corps aren’t required to distribute earnings to shareholders, so C corp business owners aren’t guaranteed annual dividends. C corps may choose to reinvest earnings and fund business growth.

The major downside to the C corp structure? Double taxation. 

Double taxation means the C corporation and its shareholders pay tax on the business’s income. First, the C corp pays tax on its net income. Second, the C corp’s shareholders pay tax on corporate dividends. 

Regardless, many business owners find that the benefits of the C corp’s flexibility outweigh the cost of double taxation.

Need help determining whether the C corp business structure is right for your business? Our entity formation professionals can support you. 

S Corp vs. C Corp: The Key Differences

As we’ve covered, S corporations and C corporations share many characteristics. The following table summarizes the key differences between S corp and C corp structures. 

Tax Implications of Choosing S Corp vs. C Corp

Let’s consider a (simplified) example illustrating S corporation vs. C corporation tax impacts. 

Compare two corporations: QRS Company is an S corp, and ABC Company is a C corp. The companies share the following facts: 

• Each corporation has two owners, and each owner holds 50% ownership.
  
• During 2023, the corporations each earned $1,000,000 and reported taxable income of $500,000.
  
• Each shareholder was subject to a combined federal and state income tax rate of 40% on corporate distributions. 

S Corp Tax Implications Example

QRS Company met all S corp requirements and did not pay federal or state income tax. 

QRS Company distributed all profits to its shareholders, so each owner received $250,000. Each owner paid taxes of $100,000 on their distributions.

The shareholders each kept $150,000 after taxes. 

C Corp Tax Implications Example 

ABC Company paid $105,000 of federal income tax at a 21% tax rate. Assuming a 7% state income tax rate, ABC Company paid $35,000 of state income tax. 

The company distributed its after-tax income of $360,000 as dividends, so each shareholder received $180,000. Each owner paid $72,000 of taxes on dividends.  

The shareholders each kept $60,000 after taxes. 

S Corp vs. C Corp: Summary of Tax Implications 

The following table compares the above example’s S corp vs. C corp tax implications. 

As you can see, the S corp and its shareholders enjoyed a lower total tax bill because S corps aren’t subject to double taxation. Further, the S corp shareholders kept more after-tax income than the C corp shareholders. 

The above example illustrates potential tax implications with a simplified fact pattern, but your S corporation vs. C corporation decision should include non-tax considerations. 

If you’re interested in S corp status for your company, we recommend consulting tax professionals who can help you consider the economic and administrative impacts.

How to Change from C Corp to S Corp (Or vice Versa)

Filing an S Corp Election

As we mentioned, C corp status is the default for new corporations. You can make an S corp election by filing IRS Form 2553, Election by a Small Business Corporation. 

Before you file, confirm your business meets the S corp requirements and prepare to provide information about each shareholder. 

Review the S corporation eligibility criteria and consult your tax professional if needed. 

After you receive the IRS’s approval, you may need to notify state and local taxing agencies of your S corp status. We can help you determine which notifications and disclosures you should file. 

Terminating an S Corp Election

If you wish to end your S corp status and revert to a C corp, you can file a statement of revocation with the IRS.

The statement should include your company’s information, shareholder details, and shareholder signatures. Be sure to review the full requirements and due dates before filing. 

Partner with Experts Who Understand What’s Best for Your Specific Situation

How do you know whether the S corp vs. C corp business structure is best for your company? 

Ultimately, your decision requires weighing each entity type’s benefits and drawbacks. 

Consider your company’s plans for raising capital and your shareholders’ tolerance for double taxation. Think through the requirements of each corporate structure – do you have the bandwidth to maintain compliance?

Partner with 1-800Accountant for your business structure decision. Our tax professionals can help you understand the complex implications for your business. We’ll support your entity formation and assist with your business compliance.